Brocade's Storage Networking Business is Undervalued, Analyst Says

Tuesday Mar 23rd 2010 by Paul Shread
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Brocade shares are being unfairly punished for the company's missteps in the Ethernet switch market, according to one analyst.

Brocade's (NASDAQ: BRCD) Ethernet switch business may be weak, but its storage networking business remains strong, a Wall Street analyst said today.

Analyst Brian Marshall of Broadpoint AmTech wrote in a research note that Brocade's storage area network (SAN) business alone is worth more than the stock market valuation of the entire company.

Brocade shares today are trading at $5.80 a share, or $2.6 billion for the whole company. That's 70 cents less than Marshall said the company's SAN business is worth. Marshall values Brocade's Ethernet business at $1 a share, so he figures the entire company is worth $7.50 a share, or about 30 percent more than its current market value, he said.

After losing a quarter of its value due to weakness in its Ethernet switching business acquired from Foundry, Marshall wrote that "the market has overreacted to the downside. ... Based on our analysis, we believe BRCD's current low share price and valuation will be unsustainable going forward as we value the company's attractive standalone SAN business at ~$6.50 per share.

"Obviously, this implies investors are not getting the Ethernet business (FDRY) for free, but are actually having to pay a penalty to own it (despite our view that FDRY is still making money even at these depressed revenue levels)."

SAN switching comprises 80 percent of the company's sales, he said. He values the company's Ethernet business at just $1 a share, but he said that business from an OEM deal with IBM (NYSE: IBM) could turn out to be better than expected.

Marshall acknowledged that the company's Ethernet missteps mean that "it will take time for investor confidence to return. However, based on our detailed 'sum-of-the-parts' valuation analysis, it is our view BRCD's current share price/valuation is unsustainably low."

Marshall rates BRCD shares a "Buy" and calls his valuation of the company "conservative."

QLogic (NASDAQ: QLGC) has been making inroads into edge Fibre Channel switches as rivals Cisco (NASDAQ: CSCO) and Brocade slug it out in the Ethernet and core Fibre Channel switch markets.

Asked by Enterprise Storage Forum if Brocade's Foundry business has distracted the company from its core SAN storage business, Marshall replied in an email, "While I definitely think the FDRY integration efforts over the past year have taken resources away from the standalone SAN business, I still believe they continue to do well on that front. If we take the most recent quarter as example, SAN grew 17% Q/Q and 13% Y/Y...not too shabby."

It has been some time since Brocade has announced new storage networking offerings, but Marshall expects that drought to end soon. "I expect an updated FCoE announcement soon, as it has been almost a year since the 8000 was launched," he said.

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